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University of Toronto St. George
Rotman Commerce
Alexander Edwards

1. Determine Inventory Quantities Determining inventory quantities involves 1. Taking a physical inventory of goods on hand and 2. Determining the ownership of the goods 1.1. Taking a physical inventory involves actually counting, weighing, or measuring each kind of inventory on hand. Companies often count their inventory when the business is at its slowest time of year. 1.1.1. Internal control is a process designed to help an organization to achieve reliable financial reporting, effective and efficient operation and compliance with relevant laws and regulations. Internal control procedures for counting inventory include: Counting should be done by employees who do not have custodial or record-keeping responsibilities for the inventory. Each counter should establish the validity of each inventory items. This means checking that the items actually exist, and how many there are all done, and what condition they are in . Authenticity of each inventory item should be established. The count should be done by 2 people. Pre-numbered inventory tags should be used to ensure that all inventory items are counted and that none are counted more than wants. A supervisor should check that all inventory items have been tagged once and only once. 1.1.2. After a physical inventory is taken, the quantity of each kind of inventory is listed on the inventory summery sheet. Unit costs are then applied to the quantities to determine the total cost of the inventory. 1.2. Ownership of the goods must be determined. 1.2.1. In general, goods should be included in the inventory of the owner, who has legal title to them. 1.2.2. Goods in transit should be included in the inventory count of the company that has legal title to the goods. Goods shipped FOB shipping point belong to the buyer. Goods shipped FOB destination belong to the seller.  FOB shipping point: inventory belong to the buyers once shipped and inventory belongs to the seller until it is shipped  FOD destination: inventory belongs to the buyers once it reached destination and inventory belongs to the sellers once it reached buyer’s destination. 1.2.3. Goods on consignment belong to the shipper (consignor).  In some line of business, it is customary to hold goods belonging to other parties and sell them for free without taking ownership of the goods, these are called consigned goods  Under a consignment agreement, the holder of the goods called the consignee, or does not own the good.  Ownership and names with the shipper of the goods called the consignor until the goods are actually sold to the customer  Since the consignor has the ownership of that good until it is shipped a should be included in the inventory of the consignor and not the consignee because they don’t own the goods. 1.2.4. Sometimes goods are not physically on the premises because they have been taken home on approval by a customer those goods should be added to the physical inventory count because they still belong to the Sellers. Goods that are sold to but the Sellers is holding them for alteration or until they are paid off or deliver it to the customer, those goods are not included in the physical inventory because the ownership of the good is passed to the customer. 2. Inventory cost determination method (perpetual) Entries to record purchases of merchandise are do not show the unit cost of each item of merchandise that was acquired. However the unit cost is needed in order to prepare the entry to report the cost of goods sold and remove the cost of the items sold from inventory. Because units of the same inventory items are typically purchased at different prices, it is necessary to determine which unit cost to use in the preparation of the cost of the goods sold. 2.1. Specific Identification The specific identification method tracks the actual physical flow of the goods in a perpetual inventory system. Each item of inventory is marked, tact, or coded with its specific unit cost so that, at any point in time, the cost of the ending inventory and the cost of the goods sold can be determined. Specific identification is appropriate and required for goods that are not ordinarily interchangeable, and for goods that are produced and segregated for specific projects. Specific identification is used mostly in situation involving a relatively small number of costly items that are easily distinguishable and when a company sells high unit cost items that can be clearly identified from purchased through to the sale. This method is very time consuming and expensive to wide and not practical in many saint which it can also allow the management to manipulate profit. Cost formulas: Under a perpetual inventory system, the custom goods available for sale is allocated to the cost of goods sold as each item is sold. Under a periodic inventory system, the allocation is made only at the end of the period, with the cost of goods sold them calculated by deducting the ending inventory from the cost of goods available for sale. FIFO and Average cost are called the cost firm was because they assume a flow of cost that may not be the same as the actual physical flow of the goods, unlike the specific identification method. 2.2. First-In, First-Out (FIFO) The FIFO method assumes that the earliest goods acquired are the first ones sold. This does not necessarily mean that the oldest units are in fact sold first, only that the cost of the day oldest units is recognized first. The allocation of cost is done at the end of the period, once the physical inventory count has been done. The cost of the ending inventory is obtained by taking the unit cost of the most recent purchase and working backward until all units of inventory have been costed.  Under FIFO, the cost of the oldest good on hand before each sale is allocated to the cost of goods sold.  FIFO assumes that the first goods purchased are the first ones sold. The cosr formula always indicates the ordering of selling. 2.3. Average Cost Under this method, the allocation of the cost of goods available for sale between cost of goods sold and ending inventory is made based on the weighted average unit cost of the merchandise. Cost of goods available for sale ÷ Total units available for sale = Weighted average cost per unit Average unit cost is done by weighting the quantities purchased at each unit cost. Consequently, a new average is calculate or “moves” after each purchase (or purchase return) . This is known as the moving average cost formula in a perpetual inventory system. The cost formula uses the average cost of the goods that are available for sale to determine the cost of goods sold and ending inventory. When the perpetual inventory system used the average unit cost is determines after each purchase (or purchase return). See illustration 6-6 in page 305 3. Effects of Cost determination methods Choices of cost determination method  If companies have goods that are not ordinarily interchangeable, or goods that have been produced and segregated for specific projects, they must use the specific identification methods to determine the cost of their inventory.  How should company choose between FIFO and average? 1. Choose a method that corresponds as closely as possible to the physical flow of goods. 2. Report the inventory cost on the statement of the financial position that is close to the inventory’s recent cost. 3. Use the same method for all inventories having a similar nature and usage in the company.  After a company chooses a method of determining the cost of its inventory, that method should be used consistently from one period to another for the purpose of comparability of the financial statement over suc
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